Deals Done in a Downturn Can Outperform

In the midst of a pandemic-induced recession, this article is a reminder that successful deals can still be done in downturns.

Deals Done in a Downturn Can Outperform | Firmex

In the early 2000s, Laurence D. Fink, CEO of BlackRock, and Robert E. Diamond Jr., president of Barclays, discussed the possibility of doing a deal, but decided the timing wasn’t right. Then in 2009, in the middle of the financial crisis and Great Recession, Fink heard that Barclays was looking to sell Barclays Global Investors (BGI).

That’s when BlackRock acquired BGI. But the deal wasn’t just an opportunistic acquisition of a cheap asset. It was reported at the time that personnel and product integration between the two firms was “well thought-out,” and they expected an 80% synergy between their products. In fact, as Morningstar stated several years later, “the BGI deal was instrumental in making BlackRock the world’s premier asset management company.”

As we enter the current recession, BlackRock’s acquisition of BGI is a reminder that successful deals can still be done in downturns.

The World Economy is in or Entering a Recession

In its April 2020 World Economic Outlook, the International Monetary Fund (IMF) predicts the world will experience the “worst economic downturn since the Great Depression” this year.

Global real GDP is expected to decline three per cent year-over-year in 2020. As in past recessions, M&A activity has slowed abruptly—and dramatically—with the slowing economy.

Merger Activity has Slowed Precipitously

In the first quarter of this year, global M&A activity fell 28% from the same period in 2019.

It took years for U.S. M&A activity to recover after large declines in the total volume and value of deals during the Great Recession and dot-com bust. But despite the drop in M&A activity during economic downturns, “markets reward dealmakers who take the risk of pursuing acquisitions in a weak economy,” according to Boston Consulting Group (BCG).

Deals Done in a Weak Economy Might Outperform

One year after announcement, relative total shareholder return (RTSR) for deals done during a weak economy is positive—and seven percentage points higher—than RTSR for deals done during strong economies, according to BCG research.

BCG studied thousands of acquisitions by public buyers from 1980 to 2018 with a transaction value of at least US$250 million. It found that two years after announcement, the RTSR for deals done in weak economies was 9.6 percentage points higher than the RTSR for the deals done in strong economies. 

PwC also looked at companies that made acquisitions during the 2001 recession and found that six months after the transaction was announced, median shareholder returns were 2.43% greater than the relevant S&P 1500 sector index. And a year after announcement, median shareholder returns were 7.01% greater than the relevant index.

What Factors can Contribute to Outperformance?

Those who act quickly may see better results. Deals done in the early stages of the 2001 recession saw higher returns than deals done later. And experience matters. Research has shown that deals made in slow economies work best for experienced deal-makers compared to occasional buyers.

Rather than relying on selective, organic or large deal M&A, firms that use programmatic M&A where they make “many relatively small transactions as part of deliberate and systematic M&A programs” see better total returns for shareholders with less volatility and risk at all times, including during economic downturns.

And while markets may not like bold strategic moves in the short run, in the medium term companies that buy outside their core business are better rewarded by the markets.

BlackRock was focused on active asset management, so the acquisition of BGI—a leader in passive management—was a move outside its core business. And it was transformational in that it made BlackRock ready for the growth in demand for ETFs that would be seen over the next decade.

What Should Firms be Doing to Increase M&A Success in Downturns?

To be ready to act in a downturn, firms should have a strategy in place and know what types of acquisitions they’re looking for. And they should understand how an acquisition will contribute to their competitive advantage. In downturns, M&A can be used to transform, like BlackRock, or to be ready to move out of the recession and adapt to changes in the business environment.

To execute on its strategy, a firm must have a dedicated team in place and commit resources to M&A so they’re ready to act quickly and take advantage of opportunities that might crop up.

The target list needs to be revisited, considering new valuations. Desirable targets may present value they didn’t before. And what may have previously been a desirable target may not make sense in light of factors such as new regulations or business models resulting from the downturn. While it’s tempting to leap at what looks like a cheap asset, it’s important to remember that things are typically cheap for a reason.

While due diligence is always important, it’s even more so in a downturn. One reason that acquisitions in the same industry may not perform as well is that acquirers, thinking they “know the business,” may be lax on the due diligence around these acquisitions.

We’re entering difficult times. But with discipline, careful due diligence and courage, it’s possible for firms to make acquisitions that exceed their expectations.

Illustration by Christy Lundy

Douglas Warren

Doug Warren, MA, CFA, writes for the financial industry, drawing on experience he gained working as an institutional portfolio manager, bond salesman, credit analyst and financial advisor.